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Analysis: After Web stocks boom, investors wary but rout unlikely

A man is silhouetted against a video screen with an Facebook logo as he poses with an Dell laptop in this photo illustration taken in the central Bosnian town of Zenica, August 14, 2013. REUTERS/Dado Ruvic

By Alexei Oreskovic and Rodrigo Campos

SAN FRANCISCO/NEW YORK (Reuters) - For investors in internet stocks, it was a banner year: shares of many companies doubled as revenue climbed and on forecasts for rip-roaring growth in earnings. But the gains haven't been anxiety-free, thanks to uncomfortable memories of the 1999 Internet bubble and subsequent bust.

Market strategists and tech experts say the comparison is overblown. While there is the potential for a decline in some Web company stock prices that are out of line with their earnings outlook, they say there is little chance of a bloody retreat.

Most importantly, this year's stars, such as Facebook and Netflix, actually make money. Many of the web companies that were emblems of the previous era had little prospect of ever being profitable and some hardly had any revenue - basing their boasting on non-financial metrics such as numbers of eyeballs, or page clicks.

The Internet and the ways people use and access it have been transformed in the past 14 years. In 1999, it was mainly through slow dial-up services using a desktop computer, now there is faster broadband and mobile access from phones and tablets. Web-based advertising has grown into a mature, viable business, and computing speeds support video and sophisticated gaming.

The market is much more rational than it was in 1999, argues Jeff Dachis, who co-founded and was chief executive of Razorfish, an online ad firm that went public in 1999, and is now part of France's Publicis Groupe.

"What you had then was 100 times the volume of stock with little to none of the credibility or weight in the marketplace that a Facebook or a Twitter has today," said Dachis. "Nobody denies now the growth of online advertising or digital marketing."

WARNING SIGNS

Facebook, Google and Netflix are among the internet companies set to finish 2013 at or near record highs. Less-weighty Web companies such as Yelp and Pandora saw their shares triple.

That is not to say there aren't warning signs. The 160-percent gain in shares of Twitter since its November initial public offering raises awkward questions about the levels of speculative froth given the company has not yet earned a cent.

Also, consumer names like Snapchat and Pinterest are raising eyebrows by garnering millions of dollars in financing at multi-billion dollar valuations - despite being decidedly in the red.

According to CB Insights, there are 26 U.S. tech companies that have raised financing at valuations of $1 billion or more and that could go public in 2014, including Uber and Square.

Hedge fund manager David Einhorn, who has often taken short positions on richly valued stocks, in October asked in a letter to investors whether history was being repeated. "When ... conventional valuation methods no longer apply for many stocks, we can't help but feel a sense of déjà vu," he said.

Still, internet companies are trading at much cheaper valuations than their counterparts in the late 1990s. The stratospheric multiples that defined companies such as Webvan (388 times revenue in 1999) and VerticalNet (268 times sales) are unheard of today.

Twitter, which trades at 73 times its past year's revenue, is among the most richly valued Web stocks by that measure. Google, Netflix and Salesforce.com all trade at below 10 times their trailing twelve-months' revenue.

"The end markets - internet advertising, online retail, online travel - those markets are just dramatically more developed today than they were in ‘99, 2000," said Mark Mahaney, who began his career covering internet stocks in the 1990s at Morgan Stanley, working with star internet analyst Mary Meeker.

TOIL AND TROUBLE

The bursting of the dotcom bubble ranks among investment history's greatest debacles. From its peak of 5123.52 on March 10, 2000, the Nasdaq Composite Index lost 78 percent of its value in just over two-and-a-half years.

Nearly 14 years later, the Nasdaq has still not regained those lofty levels even as most other major U.S. averages have surpassed previous highs, another indication that the market is far from where it was back then.

The turn of the decade came replete with stories about extravagant parties, unabashed flogging of dubious names by investment professionals and startup CEOs, and tales of cash outlays that boggle the mind today, including a Super Bowl 2000 that saw nearly 20 dotcom companies spending about $1.1 million apiece on advertising spots - just before many went under.

At the end of 1999, 8 out of 10 of the most highly valued stocks were tech companies, led by Yahoo trading at almost 577 times projected 2000 earnings, according to S&P Dow Jones Indices. Fellow dotcom-era corporations America Online and Cisco Systems Inc - the latter prized because it dominated the market for networking equipment that enabled internet connections - clocked in at 223 times and 102 times, respectively.

Fast-forward to 2013, and just four dotcoms rank among the year's 20 biggest gainers on the S&P 500, led by Netflix's quadrupling. Yahoo is at No. 10 after having doubled. Facebook has more than doubled.

Other big gainers include Best Buy and Micron Technology.

"The consensus view in the market is that things are bubbly but since the valuations are not as expensive as 1999, there is room to run," said Mike O'Rourke, chief market strategist at Jones Trading.

But he said such thinking may be flawed and cautioned that using one of the most expensive periods in stock market history as a comparison is extremely risky, with a limited reward. "When bubbles pop a large portion of the gains are erased very quickly," O'Rourke said.

IPOS MUCH FEWER

The lack of newly listed internet stocks provides some relief for those concerned about a possible bubble.

There were only five U.S. internet IPOs in 2013, including Twitter, compared with 86 in 1999, according to Thomson Reuters data. In fact, the number of IPOs in 1999 is greater than the combined number of public offerings every year since then.

Many companies may simply be waiting longer to take the plunge, debuting at a far more advanced stage of development than the wave of 1999 dotcoms. Facebook, an extreme example, went public with a valuation of more than $100 billion.

"Anything and everything - regardless of how asinine the business model was - was going public and getting ridiculous valuations" back in 1999, said Ryan Jacob, chief executive of the Jacob Funds.

Take eToys, the online toy store whose shares quadrupled on their debut in 1999. It spent tens of millions of dollars on pricey TV ads only to file for bankruptcy in early 2001.

With low interest rates and signs that the U.S. economy is strengthening, internet valuations could go higher in 2014 - though nowhere close to 1999 levels, Jacob says.

He points to LinkedIn's 14 percent decline since more than doubling in the first nine months of the year, as sign that investors aren't losing their heads. "You did have a part of the market that got ahead of themselves, and then took a breather" in 2013, Jacob said.